The metals and mining sector is perhaps the most beaten-down sector in the UK equity market. This has presented some highly attractive opportunities for the long-term contrarian investor. However, due to the cyclical nature of this industry, and the uncertainty surrounding the outlook for China, investors have to be careful which companies they pick to try and play the rebound, if and when it occurs.
As two of the sector’s largest players, Glencore (LSE: GLEN) and BHP Billiton (LSE: BLT) could both be great ways to play the recovery, but if you had to pick just one, which should you choose?
Biggest is best
BHP is the world’s largest diversified mining company, and it’s well-positioned to ride out the current commodity slump. That said, the company has made some mistakes over the past 10 years.
For example, BHP paid $20bn to acquire some US shale oil producers at the height of the shale oil boom, a decision that has cost the company over $20bn in writeoffs and exploration-related expenses. Moreover, the company’s decision to spin-off of its non-core assets into a new business called South32 cost nearly $1bn to put into action and has so far created little in the way of value for investors.
BHP has made plenty of mistakes but unlike smaller producers, the company has scale on its side. Even after cutting billions out of its capex budget, BHP is still investing for growth and can sustain its debt pile for the time being. It’s now widely expected that BHP will cut its dividend payout this year so if you’re looking to buy the company’s shares for their 11.8% dividend yield, it might be wise to look elsewhere.
Defensive black box
While BHP has size on its side, Glencore has its trading arm. This trading division, which has been called a ‘black box’ by analysts in the past, helps the company remain profitable during times of volatile commodity prices. As the trading arm is focused on buying, selling and transporting commodities, the division tends to remain profitable at all points throughout the commodity cycle. Credit Suisse believes Glencore’s marketing business should be able to deliver earnings of between $2.3bn and $2.4bn next year, enough to support the rest of the group through the downturn.
Still, one of the concerns the market has about Glencore’s outlook is the company’s colossal debt pile. However, the group is targeting $13bn in debt reduction by the end of 2016 and has already raised $8.7bn by suspending dividend payments, spending less, selling assets and a $2.5bn share offering. And one of the reasons why the company has been so quick to fulfil its debt reduction promise is that Glencore is still majority-owned by its managers and founders. BHP, on the other hand, has a comparatively low level of insider ownership.
The bottom line
All in all, when it comes to choosing between BHP and Glencore, it’s down to your own personal preference. If you’re wary of debt, then it might be wise to avoid Glencore, but if you believe Glencore’s management has what it takes to turn the company around, then Glencore could be the company for you.
